In Canada, Economic and Energy Issues Await the Next Government

With its economy in a mild recession, Canada is deciding whether or not it wants to extend the nine-year run of the Conservatives under the leadership of Prime Minister Stephen Harper. The country is holding national elections Oct. 19, and the race has been a close one. Final polling before the election indicated that none of Canada's three main federal parties are likely to win a majority, though a recent surge in support for the Liberal Party has given it some hope of gaining enough votes. More likely, elections will result in a fragile minority government.

Although Canada's domestic politics are important, its energy sector and Ottawa's potential passage of the Trans-Pacific Partnership are far more important in terms of Canada's geopolitics. Harper's Conservative government has propped up the country's energy sector as a major part of the domestic economy, but a change in Canadian leadership toward the left would not lead to policy changes that would fundamentally alter the oil and natural gas industry's position. The next government will focus on longer-term issues in the energy sector and other economic challenges, such as the need to find new trade partners and the weak global economic environment.

Canada is just barely in recession, registering -0.1 percent and -0.2 percent gross domestic product growth in the previous two quarters, respectively. This slowdown has been driven largely by the fall in energy prices. Canada's construction and manufacturing sectors have been affected somewhat, largely because of a ripple effect from the energy sector, but not as much as the oil and natural gas sectors. Despite the recession, the average Canadian is not yet experiencing the level of hardship that one would normally expect in a Western country in recession. Canada's services sector, which employs nearly 80 percent of Canadians, has been strong, and the weak Canadian dollar has helped the country's exporters. In fact, as oil prices fell in mid-2015, Canada's non-energy exports hit their highest level since before the global financial crisis and in July 15 hit an all-time high.

This highlights the dual nature of Canada's economy, which is based largely on natural resource exploitation in some areas, such as Alberta, in contrast with the more dominant industrial and manufacturing base in Ontario and Quebec. Both areas of the economy are tied closely to the United States. Canada's manufacturing, industrial and financial sectors are highly integrated with their counterparts in the United States, and almost all of Canada's natural resource exports are destined for the U.S. market (with China a distant second as a trade partner).

Potential Outcomes for the Election

Current polls show that the Liberal Party, led by Justin Trudeau, has built a slight lead, claiming between 35 and 40 percent of the vote over the Conservative Party's 30 percent. Harper's nearly decadelong tenure as prime minister has inspired an "Anybody but Harper" sentiment among the opposition voters. Both the centrist Liberal Party and the other major opposition party, the more left-leaning New Democratic Party, have benefited from this and are trying to outmaneuver each other. In the last month, the Liberal Party has strengthened, gaining some popularity among New Democratic Party supporters.

Despite its lead, the Liberal Party may not be able to win the 170 seats needed for an outright majority. Trudeau could attempt to form a coalition with the Conservatives or, more likely, with the New Democratic Party, but he has said he is unwilling to enter a formal coalition with the New Democratic Party so long as its current leader, Thomas Mulcair, remains at the helm.

A Trudeau-led minority government could pull support from both the New Democratic Party and the Conservatives to pass legislation on issues of common concern. For example, the New Democratic Party and the Liberals could work together on environmental concerns targeting the hydrocarbon sector, while the Liberals could call upon the Conservatives for support in pushing through the Trans-Pacific Partnership — which the New Democratic Party is strongly against — in its current form.

Should the Conservatives narrowly win, Canada would be in a more interesting position. Both the Liberals and the New Democratic Party are set on removing Harper as prime minister; perhaps the most common ground that Trudeau and Mulcair have is in their opposition to Harper. This means Harper quickly would face a vote of no confidence from the opposition. If this happens, Canada's governor general could ask either Trudeau or Mulcair to attempt to form a government, or Harper could call for new elections. This could create a constitutional crisis — a moment of uncertainty over which party is actually the ruling party. This has occurred in Canada before. As recently as 2008, the New Democratic Party and the Liberals tried to enter a formal coalition to remove Harper, but the prime minister asked the governor general to suspend parliament to prevent the no-confidence vote. Such uncertainty could impact Canadian markets for several months.

Such a political crisis is possible, but a government led by the Liberal Party's Trudeau is more likely. In any scenario, Harper's influence over Canada's parliament and the country itself is weakening. Whichever kind of government emerges, it will have to deal with an economy and energy sector that are fighting longstanding structural issues.

Challenges for the Economy and the Energy Sector

Canada's new government will need to deal with a number of issues. The global economic environment remains weak, and with the U.S. Federal Reserve delaying an interest rate hike over concerns about this international weakness impacting the economy in the United States — Canada's main economic partner and destination for exports — Canada's economic prospects are equally gloomy. Moreover, one of Canada's long-term goals is expanding its trade options beyond the United States. Canada's energy exporters are also looking for alternative export markets, such as liquefied natural gas export options or increasing exports from the Pacific Coast. Canada can only expand its trade partnerships on a small scale, given the size of its southern neighbor, but this is one of the reasons Canada is pushing for free trade negotiations such as the Trans-Pacific Partnership.

Canada's high-cost environment — including high wages for laborers — is problematic for investors, and while a weakening Canadian dollar can offset some of that cost, it can only do so much. Depending on the shape of the next Canadian government, it may implement some of the economic policies championed by the New Democratic Party that protect Canadian workers. The opposition party's support for trade union-backed policies, epitomized by its opposition to the Trans-Pacific Partnership, could exacerbate concerns about Canada's labor competitiveness. In the longer term, Mexico's greater success in attracting manufacturing investment, including production plants used to supply the U.S. and Canadian markets, would also affect Canada's economic situation and place even more importance on the Canadian financial, business and technology sectors.

Canada's most important industry to the rest of the world is, of course, its energy sector, which is facing numerous problems. The main issue is one of transportation. Canada's oil production is showing long-term growth, but the country's oil pipeline network (and that of the United States) is congested, and Canada is looking at alternative pipeline projects. Meanwhile, the U.S. shale gas revolution has eliminated Canada's largest natural gas market, forcing Ottawa to look at alternative markets overseas.

The number of projects under consideration is lengthy. For oil exports, Canada has considered the Energy East Pipeline, the Northern Gateway Pipeline and, of course, Keystone XL. For facilitating natural gas exports, the country has considered numerous LNG options in British Columbia. The composition of Canada's new government will help determine the future likelihood of these projects. For the last decade, Harper and the Conservatives have embraced almost every pipeline and export option, whereas the opposition has been more reserved in its support. Both the Liberal Party and the New Democratic Party are more likely to approve of specific pipelines that support their voting blocs rather than offer the broad support for energy projects generally. One pipeline fitting this bill would be the Energy East Pipeline connecting Alberta's oil production facilities with ports and refineries in eastern Canada. This project could provide more jobs, putting it more in line with the New Democratic Party and Liberal Party platforms.

Another complicated issue for the Canadian energy sector is oil development costs. The country's oil sands developments are among the most expensive oil deposits in the world and perhaps the most at risk of seeing lackluster investment and the cancellation or freezing of projects because of low oil prices. Even if oil prices begin to rise, most of Canada's oil sands developments would need prices closer to $80 per barrel (and sometimes higher) to break even. That much of a price rebound seems unlikely to occur during the next government's term, which could be short. If a Trudeau-led government emerges, we can expect the Liberals — with backing from the New Democratic Party — to put more pressure on oil and natural gas companies through taxation. However, Trudeau and Mulcair recognize the pressure the industry is already under and how much the rest of Canada depends on the energy sector, so any movements to increase tax revenue or environmental standards in the oil and natural gas sector will be minor.

Canada's new government also could complicate Ottawa's pledges for the U.N. Conference on Climate Change, to be held in November and December in Paris. In May, Harper's government formally submitted a pledge to reduce greenhouse gas levels by 30 percent by 2020, using a sector-by-sector approach. The New Democratic Party has supported a national cap-and-trade plan, and the Liberals have promised some sort of carbon-pricing regime. Either of these plans would be a departure from Harper's position at a critical juncture of the U.N. climate change deal.

Although it looks like Harper and the Conservatives are in danger of losing after almost 10 years in power, a change of focus away from major energy producers and toward issues more important to the Liberals and New Democratic Party — such as Canada's manufacturing base — will not significantly alter Canada's economy or the position of its energy sector. The main forces affecting both are external. All the next government can do is react.